Is universal proxy voting a boon or bust for directors?

At one time, in the not so distant past, battles at annual meeting had a distinct, nearly universal pattern. Conflicts would often be about returning shareholder value by increasing dividends or making leadership and strategic changes.

Today, the battlefield is more complex, its soldiers more diverse. Concerns raised before, during, and after at annual meetings include social issues, sustainability efforts, and board scrutiny. Are directors skilled, diverse, and performing up to expectations? Are they “overboarded” with work for other companies and paid appropriately? Do they possess needed skills, in cyber-security for example, of is fresh blood needed?

The options for shareholders to vote out and replace directors are also changing, with an Oct. 26 proposed rule from the Securities and Exchange Commission that would require that parties in a contested election to use universal proxy cards that would include the names of all board of director nominees. This would allow shareholders to vote by proxy in a manner that more closely resembles how they might vote in person at a shareholder meeting. The SEC also proposed amendments to the form of proxy and proxy statement disclosure requirements to specify clearly the applicable voting options and voting standards in all director elections.

‎"If these rules are adopted as proposed, for the first time the SEC would require a minimum level of solicitation in order to conduct a proxy contest,” says Brian Breheny, a partner at law firm Skadden, Arps, Slate, Meagher & Flom. “That's a significant change to current practice.” The SEC staff, and Chairman Mary Jo White, “are focusing on replicating, as much as possible, the voting options available to shareholders if they attend the annual meeting,” he added.

Currently, under existing proxy rules, unless a shareholder attends a company's annual meeting in-person, have just two options: vote exclusively for management’s recommended directors, or go all-in on a proxy card distributed by dissidents. The proposed change would instead allow shareholders the flexibility to mix and match selections from each slate of candidates.

“We believe the proxy system should allow shareholders to achieve by proxy the vote they could cast in person at a shareholder meeting,” the proposal says. “We believe that the right to vote is of particular importance when shareholders are deciding among candidates in a contested election. While the Commission has taken some steps in the past to facilitate shareholders’ ability to choose among the nominees in competing slates, such as through the adoption of the short slate rule, we are concerned that the current proxy rules may not allow shareholders to fully exercise their voting rights.”

A universal proxy card would better enable shareholders to have their shares voted by proxy for their preferred candidates “and eliminate the need for special accommodations to be made for shareholders outside the federal proxy process in order to be able to make such selections,” it adds.

The move by the SEC was not unexpected, says Blair Petrillo, counsel at Reed Smith and an eight-year veteran of the SEC who worked in the Division of Corporation Finance’s Office of Rulemaking. She cites, for example, a speech made by Chairman Mary Jo White in the summer of 2015 that effectively promised such an effort.

Petrillo also expected the decision for a mandatory universal proxy ballot, rather than altering rules to make them possible on a voluntary basis.

“How successful this rule is, if it gets adopted, will depend on some of the details as they work themselves out through the rulemaking process,” she says. Supporters see “a way to enhance shareholder voting rights and make them closer to what they have under state law.” Critics fear a diverse slate could be a distraction for management if dissident votes prevail.

Over time, “it will be interesting to see whether it has an impact on actual vote tallies,” Petrillo adds. “If you are someone who is generally satisfied with a company, are you going to just continue to vote for management nominees as you have in the past? If you are dissatisfied with management, will you just vote for whatever slate that the contested shareholder wants you to? The effect on voting results could be less significant than you might expect.”

In comments prior to voting on the proposed changes, Chairman White once again cited the importance. “Taken together, the proposed rule changes will promote fundamental fairness and efficiency in the voting process and support shareholder rights,” she said. “At the most basic level, these goals mean that the differences between proxy voting and in‑person voting should be minimized for shareholders, both institutional and retail.”

A less than enthusiastic rebuttal came from Commissioner Michael Piwowar, who voted against advancing the proposals. “The ultimate losers in these fights will be the public shareholders of these companies,” he said. “A universal proxy may empower specific groups of shareholders, who may use their increased influence to advance their own special interests at the expense of other shareholders.”

Piwowar’s concerns reflect efforts by his Republican colleagues who have led an effort to attach budget riders prohibiting the SEC from moving forward with its planned proxy changes.

Regarding the more granular details of the proposed amendments, the SEC did take efforts to prevent a flood of gadfly nominations.

"They have prescribed certain ways the card can look, but basically left the design of the cards to the individual parties in a proxy fight, and it doesn't have to be an identical card,” says Richard Grossman, a partner with law firm Skadden, Arps, Slate, Meagher & Flom who focuses his practice on proxy contests, responses to shareholder activists, and corporate governance matters.

UNIVERSAL PROXY CARDS

The following is from a “fact sheet” the Securities and Exchange Commission prepared for its “universal proxy card” proposal.

Proxy contestants would be required to provide shareholders with a universal proxy card that includes the names of both management and dissident nominees, which would allow shareholders to vote by proxy for the combination of nominees of their choice. Universal proxy cards would be required in all non-exempt solicitations in contested elections

The definition of a “bona fide nominee” in Rule 14a-4(d) would be changed to include a person who agrees to be named in any proxy statement relating to a company’s next meeting of shareholders at which directors are to be elected. The amendment would enable parties to include all director nominees on their universal proxy cards.

The “short slate rule,” Rule 14a-4(d)(4), would be eliminated because universal proxy cards would make it unnecessary for dissidents to round out their partial slates with management’s nominees

Proxy contestants would be required to notify each other of their respective director candidates.

A dissident would be required to provide a company with the names of the nominees for whom it intends to solicit proxies no later than 60 calendar days prior to the anniversary of the previous year’s annual meeting date.

The company would be required to provide the dissident with the names of the nominees for whom the company intends to solicit proxies no later than 50 calendar days prior to the anniversary of the previous year’s annual meeting date.

Dissidents would be required to solicit shareholders representing at least a majority of the voting power of shares entitled to vote on the election of directors

Proxy contestants would be required to refer shareholders to the other party’s proxy statement for information about that party’s nominees and explain that shareholders can access the other party’s proxy statement for free on the Commission’s website.

To ensure that shareholders who receive a universal proxy card will have access to information about all nominees a sufficient amount of time before the meeting, dissidents would be required to file their definitive proxy statement with the Commission by the later of 25 calendar days prior to the meeting date or five calendar days after the registrant files its definitive proxy statement.

Universal proxy cards would be subject to presentation and formatting requirements to help ensure that universal proxy cards clearly and fairly present information

The proposed changes to require a universal proxy card would not apply to solicitations involving foreign private issuers or companies with reporting obligations only under Section 15(d) of the Exchange Act, which are not subject to the federal proxy rules, or registered investment companies or business development companies.

The proposed amendments relating to voting options and standards in director elections would apply to all solicitations that are subject to the proxy rules.

Under the proposed amendments to Rule 14a-4(b), proxy cards would be required to include an “against” voting option for the election of directors when there is a legal effect to a vote against a nominee and to provide shareholders the ability to “abstain” in a director election governed by a majority voting standard. The proposed change would eliminate the current ability to provide a “withhold” voting option when an “against” vote has legal effect. In addition, the proposed amendments to Item 21(b) of Schedule 14A would require disclosure about the effect of a “withhold” vote in an election of directors.

“Each side has the right to list their people first on their version of the universal card,” he explains. “They required a clear delineation as to who is a company nominee and who is a dissident nominee. They also put in a mechanism so that a one-off gadfly can't automatically nominate candidates. They require that the dissident commit to mailing to a majority of the shareholders and mailing their proxy no less than 25 days before the meeting. You need to have some real skin in the game to force the company to use a universal card.”

A big question: How will these new voting guidelines affect proxy access practices that are increasingly adopted by public companies? Nearly 40 percent of S&P 500 companies have adopted some form of proxy access, allowing investors who own at least 3 percent of stock for three years (or some variation on the formula) to nominate their own board candidates.

“There are approximately 300 companies now that have proxy access,” Grossman says. “Many proxy access bylaws make clear that if you have a real contest, where each party is soliciting a slate on their own cards, then you won't grant proxy access. Companies who have this restriction in their bylaws may wish to consider whether they want to eliminate the provision and allow proxy access to go forward in those situations. That would create an opportunity to have a greater number of candidates on one card and increase the chances of dispersion of votes for non-incumbent candidates, potentially enhancing the chances that incumbents win.”

Universal proxy cards could ultimately prompt more situations in which proxy advisory services like ISS and Glass Lewis recommend a split ticket.

“You may see a greater predilection on the part of the proxy advisory services to mix and match their recommended candidates across the company and dissident slates,” Grossman says. “This is currently difficult for their clients to implement. They would need to arrange to go to the meeting or send a legal proxy to the meeting to mix and match their votes across the slates. If this rule gets passed in its proposed form, it will be much easier to implement a split ticket recommendation from the advisory services.”

The National Association of Corporate Directors has also weighed in with its concerns. It recognizes shareholder interest in universal ballots and the potential benefits of a universal proxy, “however, we oppose universal ballots because the ‘mix and match’ voting approach they empower can yield an ineffective group of directors,” says President Peter Gleason. “The traditional slate approach is a well-founded one, as slates are created by people who have given thought and study into creating an optimal board.”

The U.S. Chamber of Commerce, through its Center for Capital Markets Competitiveness, has expressed similar reservations.

“The American public-company model has been the gold standard globally and this proposal is a major step backwards,” says Executive Vice President Tom Quaadman. “Mandating a universal ballot at all public companies would increase the number of proxy fights, turn director elections into annual political-style campaigns, and impact public companies’ ability to provide a return to investors.”

He fears that special interest activists will be able to elect directors who are “not beholden to the best interests of either the business or investors.”

The view from those supporting the proposal, however, is one of optimism.

The Council of Institutional Investors petitioned the SEC in 2014 to amend its rules to require universal proxy cards. In June 2015, it petitioned the SEC to provide guidance for disclosure on the method by which votes are counted in director elections.

“Currently, when there is a contest, investors voting by proxy are effectively disenfranchised because they have no practical ability to vote for the combination of management and dissident nominees they believe best serve their economic interests,” says CII Executive Director Ken Bertsch. “Universal proxy cards level the playing field.”

Jason Soncini, an attorney with law firm Kleinberg Kaplan, focuses much of his practice in the area of investor activism and providing strategic guidance to investors and public and private companies and their boards of directors on proxy contests and consent solicitations. He sees the proposal, once final, as “a boon not just to activists but to investors generally.”

“This truly is a step in the right direction of what should be the best mix of people to serve on the board of directors,” he says. “Stockholders are receiving a tremendous benefit here because they will have an opportunity to vote for whom they feel will be the best people to serve on the board of directors as opposed to the current regime which effectively is all or nothing; vote what’s on our card or don’t vote.”

Soncini does not share concerns about a rule “hijacking the corporate process.”

“I don’t necessarily think that all of the ‘Chicken Little’ complaints here are going to come to fruition,” he says. “The SEC did a good job here of limiting this to the people who are serious. People are still going to think long and hard about whether it makes sense to conduct a campaign.”

While the proposal “isn’t going to open up the floodgates,” Soncini expects it will build upon an increasing trend of activists and management meeting behind the scenes to find common ground.

“You are always going to have companies that are entrenched, their way or the highway,” he says. “But the reality is that contested, scorched earth campaigns don’t make sense most of the time. They suck resources from the company and from the shareholders.”

The changes will “open things up for additional negotiations, particularly if you have an activist putting forth quality nominees,” he says. “It really can’t hurt to take a step back and look at the big picture of who you are nominating to the board if you are a company, especially if these are the same people who have served for a certain number of years and maybe it is time to mix it up. In a perfect world, this will be another reason to open up the lines of communication and bring additional perspective to the board.”